Priority Sector Lending (PSL)

Priority Sector Lending (PSL) is an important policy tool in India aimed at ensuring that adequate credit is available to vital sectors of the economy that may not get timely and adequate credit in the absence of this special dispensation. Read here to learn more.

A Priority Sector Lending initiative aims to provide credit to the weaker sections of society, as opposed to funding only profitable sectors or spaces that are solely important to economic growth.

All sectors considered a priority can easily access financial support like applying for loans that the banks must allot at a lower interest rate.

Priority Sector Lending (PSL)

Priority Sector Lending was formalised in 1972 to facilitate the flow of credit to such sectors, which though creditworthy, cannot access credit from formal financial institutions.

• This initiative is designed to promote inclusive growth by directing a portion of the lending by banks to specified sectors.
• Banks can achieve their PSL targets by purchasing PSLCs. This mechanism allows banks that have surpassed their PSL targets to sell their excess lending to other banks that have not met their targets.
• This trading does not involve the transfer of assets or loan accounts but only the underlying priority sector obligation.

Monitoring and Reporting:

• Banks are required to submit quarterly and annual reports on their Priority Sector Lending performance to the RBI.
• The RBI monitors and ensures compliance with PSL guidelines, and non-compliance can attract penalties.

Objectives of Priority Sector Lending

• Inclusive Growth:
  • Ensure that credit is provided to sectors that are crucial for the socio-economic development of the country.
  • Promote financial inclusion by facilitating access to credit for underserved and marginalized sections of society.
• Balanced Sectoral Growth:
  • Support sectors like agriculture, micro and small enterprises (MSEs), and weaker sections that are critical for overall economic stability and growth.
  • Reduce regional disparities by ensuring credit flow to less developed regions.

Categories under Priority Sector Lending

The Reserve Bank of India (RBI) mandates that banks allocate a certain percentage of their adjusted net bank credit (ANBC) or credit equivalent amount of off-balance sheet exposures, whichever is higher, to specified priority sectors. The major categories under PSL are:

1. Agriculture:
   • Direct finance to farmers for agriculture and allied activities.
   • Indirect finance to entities supporting agriculture like storage units and distribution of agricultural inputs.
   • Sub-target: A specified percentage of ANBC or credit equivalent amount of off-balance sheet exposure for small and marginal farmers.
2. Micro, Small, and Medium Enterprises (MSMEs):
   • Loans to micro and small enterprises for manufacturing, service, and trading activities.
   • Loans to medium enterprises also qualify within a specified limit.
3. Export Credit:
   • Loans extended for export activities.
4. Education:
   • Loans for education, including vocational courses.
5. Housing:
   • Loans for affordable housing projects.
   • Loans to individuals for housing up to a specified amount.
6. Social Infrastructure:
   • Loans for setting up schools, health care facilities, sanitation facilities, and drinking water facilities.
7. Renewable Energy:
   • Loans for renewable energy projects including solar, wind, biomass, and small hydel projects.
8. Others:
   • Loans to weaker sections.
   • Loans to distressed persons to repay their debt to non-institutional lenders.
   • Loans for improving the infrastructure for urban poor, such as housing and sanitation.

Targets and Sub-Targets

Banks have to mandatorily allocate a portion of their Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposure (CEOBE), whichever is higher, towards PSL.

Domestic Scheduled Commercial Banks and Foreign Banks with 20 branches and above:

• Total PSL target: 40% of Adjusted Net Bank Credit (ANBC) or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.
• Agriculture: 18% of ANBC.
• Micro Enterprises: 7.5% of ANBC.
• Advances to Weaker Sections: 12% of ANBC.

Foreign Banks with less than 20 branches:

• Total PSL target: 40% of ANBC.
• No specific sub-targets.

Recent Developments for PSL

• Priority Sector Lending Certificates (PSLCs): Introduced to allow banks to achieve their PSL targets by purchasing certificates representing a certain amount of priority sector loans from other banks.
• Rationalization and Inclusion of New Categories: Inclusion of loans to start-ups up to a certain amount. Inclusion of loans to farmers for installation of solar power plants and solarization of grid-connected agriculture pumps.
• Adjustments for Regional Disparities: Priority Sector Lending guidelines include stipulations to ensure credit flow to less developed states and regions.

Benefits of Priority Sector Lending

• Financial Inclusion: Enhances access to credit for underserved and financially excluded sections of the society.
• Support to Critical Sectors: Ensures that critical sectors like agriculture, MSMEs, and renewable energy receive necessary financial support for growth and development.
• Socio-Economic Development: Contributes to the socio-economic development of the country by promoting inclusive growth and reducing regional disparities.
• Sustainable Development: Encourages investments in sectors like renewable energy and social infrastructure, promoting sustainable development.

Challenges and Issues

• Quality of Assets: Banks may face issues with the quality of assets in the priority sector, leading to higher non-performing assets (NPAs).
• Meeting Targets: Banks, especially foreign and private sector banks, sometimes struggle to meet the PSL targets due to a lack of expertise or interest in certain sectors.
• Geographical Disparities: Ensuring an equitable distribution of credit across various regions remains a challenge.
• Over-reliance on PSLCs: There is a risk that banks may over-rely on PSLCs to meet their targets, potentially undermining the intended purpose of direct lending to priority sectors.

Why in the news?

RBI has revised its priority sector guidelines to encourage banks to provide small loans in economically disadvantaged districts with low average loan sizes. The new norms discourage lending in districts with high average loan sizes.

• Starting from FY25, more weight (125%) will be given to fresh priority sector loans in districts where the loan availability is low (less than Rs 9,000 per person).

New PSL Guidelines:

• To address regional disparities, districts will be ranked based on per capita credit flow to the priority sector.
• It aims to build an incentive framework with higher weight (125%) for districts with comparatively lower credit flow and a
• disincentive framework with lower weight (90%) for districts with comparatively higher credit flow.
• Effective Period: From FY 2024-25 to FY 2026-27.
• All bank loans to MSMEs shall qualify for classification under PSL.

Conclusion

Priority Sector Lending is a critical policy in India’s financial landscape, designed to ensure that key sectors receive adequate credit for their development.

While it has successfully promoted financial inclusion and balanced growth, ongoing challenges need to be addressed to enhance its effectiveness.

Strengthening the framework and ensuring proper implementation can further enhance the impact of PSL on the overall economy.

Related articles:

• Indian Financial System
• Functions of RBI
• Differentiated Banks-Small banks vs Payment banks

-Article by Swathi Satish